Modest inflationary pressures in Q4
Inflationary pressures appear to be somewhat more muted at present than we projected in our last forecast. Domestic demand seems to have subsided as the autumn has set in, and to all appearances, merchants are making a genuine effort to keep mark-ups as low as possible while launching a variety of special offers to lure customers into their shops. The CPI looks set to rise by 1.1% in Q4, bringing inflation down to 2.4% by year-end and giving the Central Bank (CBI) the long-awaited satisfaction of attaining its inflation target for the first time since spring 2004.

Inflation at target in 2011
We expect inflation to hover around the CBI's 2.5% inflation target in 2011, averaging 2.3% for the year. As ever, this projection hinges on the stability of the króna. Furthermore, private sector wage negotiations must conclude with modest wage increases and indirect taxes and public price lists must not rise to any marked degree if the forecast is to be borne out. On the other hand, our forecast assumes that the residential housing market will begin to rally moderately in 2011, with prices rising by nearly 4% over the course of the year. If real estate market recovery is slow in coming, however, it will check the rise in the CPI over the quarters
to come.

Iceland's CDS spread under 300
Spain and Italy's spreads have also been inching downwards in the recent term, even though both countries are battling sizeable fiscal deficits. Spain's CDS spread measured 197 points at yesterday's close, and Italy's was 166, both of them lower than at any point since early August 2009. Iceland's sovereign CDS spread has also been on the decline in the recent past, although it has fallen much less sharply than those of Spain and Italy. It is unlikely that the recent drop in Iceland's spread is due to any particular domestic developments; more likely, it reflects a general downward trend in the market for risk premia. The Republic of Iceland's euro-denominated debt bore a premium of 288 bp (2.88%) yesterday, maintaining the under-300 level it has held for the past three days, surely a positive note for the Treasury.

Still in fourth place
Even though its spread has fallen markedly in the recent term, Greece is still the leader among Western European nations for which CDS spreads are traded. Iceland remains in fourth place. A resolution of the Icesave dispute could shake up the standings, given that progress in that quarter is one of the main thresholds to improved sovereign credit ratings from Moody's, Fitch, and Standard & Poor's. It is worth noting that the countries at the bottom of the list - and therefore those with the lowest credit risk in Western Europe - are Iceland's Nordic neighbours: Denmark (30), Sweden (29), Finland (28), and Norway (21).